I am a Tax Partner in WithumSmith+Brown’s National Tax Service Group and the founding father of the firm's Aspen, Colorado office. I am a CPA licensed in Colorado and New Jersey, and hold a Masters in Taxation from the University of Denver. My specialty is corporate and partnership taxation, with an emphasis on complex mergers and acquisitions structuring. In the past year, I co-authored CCH's "CCH Expert Treatise Library: Corporations Filing Consolidated Returns," was awarded the Tax Adviser's "Best Article Award" for a piece titled "S Corporation Shareholder Compensation: How Much is Enough?" and was named to the CPA Practice Advisor's "40 Under 40."

In my free time, I enjoy driving around in a van with my dog Maci, solving mysteries. I have been known to finish the New York Times Sunday crossword puzzle in less than 7 minutes, only to go back and do it again using only synonyms. I invented wool, but am so modest I allow sheep to take the credit. Dabbling in the culinary arts, I have won every Chili Cook-Off I ever entered, and several I haven’t. Lastly, and perhaps most notably, I once sang the national anthem at a World Series baseball game, though I was not in the vicinity of the microphone at the time.

IRS Releases Long-Awaited Draft Instructions To Form 8960: Computing New 3.8% Tax On Net Investment Income

My first concern was mentioned above. The computation of the taxpayer’s net gain or loss is driven by the completion of an off-form worksheet that will require the taxpayer to be well versed in the concepts found in Reg. Section 1.1411-4. You can read about those concepts here.

Next, because the final regulations treat the excess losses as “properly allocable deductions,” you may have expected to see those amounts appear in Part II of the draft form alongside other allocable deductions like investment interest expense or state and local taxes. Instead, the Form 8960 simply allows Line 5d – the total of gains or losses included in net investment income – to be negative.

Under newly published proposed regulations, a taxpayer who materially participates in a trade or business conducted by an S corporation or partnership will not include in net investment income any gain from the sale of a membership interest in the corporation or partnership unless a deemed sale of the assets of the entity would have yielded gain that would be included in the taxpayer’s net investment income.

Also under those regulations, a taxpayer who sells the membership interest on the installment basis must compute the amount of the gain to be included in net investment income in the year of sale. Any amount of the gain that is excluded from net investment income is added to the taxpayer’s basis in the membership interest for purposes of computing the gross profit percentage and resulting gain in subsequent years for purposes of determining net investment income.

Assume A sells S Co. stock with a basis of $10,000 for $100,000, to be paid $20,000 in the year of sale and in each of the next four years. Assume A opts not to use the simplified method, and determines under the deemed asset sale steps that $50,000 of the gain must be included in net investment income. This means the “excluded gain” is $40,000 ($90,000 gain less $50,000 included in net investment income.)

A must increase his basis in the S Co. stock of $10,000 by the $40,000 of excluded gain, bringing his basis to $50,000. This brings A’s basis for purposes of the net investment income tax to $50,000, and his gross profit percentage is 50%.

Each year, when A receives $20,000 on the installment note, for chapter 1 purposes he will recognize $18,000 of gain (gross profit percentage of 90% * $20,000 cash). The amount included in net investment income, however, would be only $10,000 (gross profit percentage of 50% * $20,000 cash).

Thus, over the five years, A would include $50,000 in net investment income, and $40,000 would be excluded from net investment income.

Many tax advisors have wondered how this will impact taxpayers who sold a membership interest prior to 2013, because Section 1411 was not in place at that time. Did this mean that taxpayers were resigned to including the entire amount of gain from per-2013 sales that is recognized in 2013 and beyond in net investment income?

The regulations seemed to indicate that this was not the case, and the draft instructions confirm this conclusion, providing:

If you disposed of a partnership interest or S corporation stock in an installment sale transaction to which section 453 applies, you need to calculate your adjustment to net gain in the year of the disposition, even if the disposition occurred prior to 2013. The difference between the amount reported for regular tax and NIIT will be taken into account when each payment is received.

The instructions go on to explain that if you sold the membership interest prior to 2013, in the first year you are subject to the net investment income tax you are required to attach to your return a statement explaining your computation of the excluded amount, as well as other required disclosures. In addition, the worksheet on page 9 will walk you through a computation whereby you first include in net investment income the current year gain recognized under the installment method for income tax purposes before backing out the amount excluded from net investment income as determined in my example above.

Below is a PDF of the instructions. Take a look, and if you have any questions, you can find me @nittigrittytax. Or you can read the 13,000 word definitive Q&A on the topic, found here.

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These articles on the Net Investment Income give a great breakdown of the types of income subject (and not subject) to this new tax, as well as, illustrate why you need a competent tax professional preparing your tax returns.